Big Oil Remains a Big Dividend Trap

Brett Owens, Chief Investment Strategist
Updated: October 27, 2015

This time last year, crude oil was selling for more than $90 per barrel. Today it’s half that, and yield hunters are excitedly sorting through the spill in oil stocks. Stalwarts like Chevron (CVX), Exxon Mobil (XOM), and BP plc (BP) are paying 5.6%, 4%, and 7.8% respectively. At first glance, these look like great deals from reliable dividend payers. Unfortunately, these “yield bargains” are likely to cost you a few times more than you’ll earn in payouts.

No matter how well these companies run themselves, the actual price of oil is outside of their control. And when the goo is in freefall, their stock prices get drilled. Exxon fared the least worst of the three over the past year, shedding “just” 27%. BP dropped 33% and Chevron, which some incorrectly believe is insulated from falling oil prices thanks to the diversity of its operations, fell 40% over the same time period.

A mid-to-high single digit yield isn’t a very good consolation prize for double-digit losses. And these stocks are still at risk, because the price of oil isn’t done dropping. The two factors that sent it spiraling in the first place are still present:

Record supply inventories, coupled with…

A large number of long contracts in the hands of money managers.

In April 2014, I warned that then-$103 crude was due for a drop. U.S. crude oil inventories were at 5-year highs, yet money managers were net long 319,000 contracts on crude oil futures. They were essentially betting that the goo would continue higher in the face of record supply and stagnant demand. These wagers didn’t work out, and the oil futures gaming table tipped over onto itself.

When the price of crude oil initially fell, the waterfall of money managers selling their long contracts soon sent the price cascading down. A lower and lower oil price became a self-fulfilling destiny, as the speculators sold 200,000 futures contracts over the next 18 months, creating a wave of selling pressure.

And there’s still more to come.

Today, money managers remain net long oil by 110,000 contracts. That’s a sizeable amount of fuel to drive crude’s continued crash. And at 455 million barrels, U.S. crude oil inventories haven’t been this high at this time of year in more than 80 years (according to the U.S. Energy Information Administration). As oil continues to drop over the next year or two, you’re not going to want to hold the oil majors in your portfolio – no matter what they’re promising in dividends.

Besides, these companies have significant restructuring ahead of them to fund these payout levels. BP, for example, will earn just enough money this year ($2.41 per share in 2015) to be able to pay its dividend ($2.40 per share). Over the past two quarters, Chevron paid out more per share than it earned ($2.14 in dividends versus $1.67 in earnings). And Exxon’s payout ratio rose to 73% last quarter, which is very high for a company that usually keeps this below 35%. (I usually like to see a payout ratio below 50% myself – the lower the better).

On the surface these dividends may look like easy money. But the companies paying them are struggling to have viable business models at $45 prices. It’s going to get worse for them as the goo slides down towards $30 per barrel. Stay away from this mess until someone else cleans it up.

In addition to these three big oil puddles, I found 11 more stocks that are yield traps posing as dividend aristocrats. You should make sure that none of these issues are in your portfolio, as I believe you’re at risk for a 20% loss or more for each one that cuts their dividends. You can get my report right here: The Dirty Dozen: 12 Dividend Stocks to Sell Now.